Why the U.S. Should Be Downgraded

The world has lost its faith in the U.S. It no longer deserves to be a Triple-A credit.

This was encapsulated in the nods of agreement that were seen in a packed auditorium at a Washington conference of international bankers on Friday whena visibly angry BlackRock Inc. CEO Laurence Fink told the audience that the U.S. is not a “principled nation.”

When men and women who control tens of trillions of dollars in U.S. investments are indicating they’ve lost their faith in America, it goes to the very question of whether the U.S. deserves to be at the center of world finance. So, whether or not Fitch Ratings follows through on the “Negative Watch” status that it placed on its top-notch U.S. rating Tuesday, it’s clear now that the dysfunctional American political system no longer justifies a Triple-A rating from anyone.

It matters not whether the U.S. is actually forced into a devastating default–still an extremely unlikely event. Triple-A credits do not behave like this.

In top-rated countries, politicians do not use instruments like the federal debt ceiling as an extortionist political tool. In allowing that to happen, the U.S. is abrogating its responsibilities as issuer of the world’s reserve currency and as protector of the “risk free rate.”

The seemingly endless rounds of political brinkmanship are bad enough. What makes it worse is that gross government debt stands at an uncomfortably high 109% of GDP, according to International Monetary Fund estimates, while the Congressional Budget Office forecasts that Social Security and Medicare obligations will grow exponentially over the next few decades.

With so much at stake, the U.S. can’t depend on foreign investors to keep rolling over its debts just because the dollar’s reserve-currency status locks them into that trade. It’s no coincidence that Chinese news agency Xinhua ran an op-ed Monday calling for a “de-Americanized world.”

Ratings are relative concepts. America’s can only be considered against those of other countries. And if you look at the 15 or so sovereign Triple-A ratings from Standard & Poor’s Ratings, Moody’s Investors Service or Fitch, you find political systems and debt management programs that engender far more confidence than that of the U.S. In many, it comes down to a political structure that inoculates long-term government debts from politics.

In Australia, for example, where the IMF estimates that gross public debt stands at just 27.6% of GDP, mandated employer and employer contributions have built up $1.5 trillion in privately held retirement assets–the fourth-largest such stockpile in the world behind the far bigger U.S., Japanese and British economies. Just to be sure, though, an independently run Australian Government Future Fund ensures that civil servants’ pension claims are fully funded into the future. Meanwhile, the country’s government-funded universal health care program has kept per-capita medical costs at less than half that of the United States, leaving it in far better financial shape than Medicare.

Then there’s Norway, which has no debt, only assets–$785 billion of them to be precise, more than 150% of GDP. That money, which is derived from the country’s giant oil reserves, is invested by an independently managed sovereign wealth fund whose far-sighted rules force it to invest for the long term and impose strict limits on how it can spend its profits.

And in Germany, politicians are giving Americans a lesson on how to compromise. Though newly re-elected Chancellor Angela Merkel will have to grant some policy concessions to the opposition Social Democratic Party, no one doubts that her Christian Democratic Union will be able to form a stable and well-functioning grand coalition government with its arch-rival.

The counterpoint to this is an argument put forward by Canadian ratings agency DBRS Inc.’s top sovereign analyst, Fergus McCormick. Although DBRS preceded Fitch in putting the U.S. on review for downgrade last week, Mr. McCormick argues that the deeply “institutionalized” nature of the U.S. financial system–the centrality of the dollar in the world system, the depth of its capital markets–ultimately justifies its Triple-A rating. As such, Mr. McCormick believes the U.S. should, for now, only be downgraded in the event of an actual default on debt securities.

Fitch is thinking differently–and, in my mind, correctly. Here’s the key paragraph in its statement Tuesday: The “prolonged negotiations over raising the debt ceiling…risks undermining confidence in the role of the U.S. dollar as the preeminent global reserve currency, by casting doubt over the full faith and credit of the U.S. This ‘faith’ is a key reason why the U.S. ‘AAA’ rating can tolerate a substantially higher level of public debt than other ‘AAA’ sovereigns.” Fitch believes the U.S. might deserve a downgrade, even if it ends up paying its debts–simply because it can no longer be trusted.